Investment Strategy
1 minute read
Following a strong start to the year, the outlook for emerging markets may become more volatile. This trade war will differ for EM compared to Trade War 1.0. While the previous trade conflict led to supply chain redirection that benefited several EMs, this time could be different as tariffs are expected to be applied more broadly. Additionally, China’s growing dominance in export market share is causing tension not only with the U.S. but also with many emerging markets. Emerging markets are generally driven by a combination of three factors: global trade, commodity prices, and the U.S. dollar. While these factors have been favorable recently, the tide may soon turn.
Although emerging markets have rallied as the dollar weakened and commodity prices rose, they remain heavily dependent on exports. With trade tensions escalating, the outlook is becoming cloudier, and investors will need to be more selective. India has experienced a sell-off, making valuations more attractive, and its small trade share of GDP keeps it relatively insulated. Tariffs, global trade, and their impact on the dollar will be the key factors overall. If the dollar continues to weaken and the tariff impact on overall trade is subdued, EMs can move higher; however, in a strong dollar environment amid a stalled global trading environment, EMs will undoubtedly feel the pressure.
Emerging markets (EM) have had a surprisingly strong start to the year, outperforming the U.S. in Q1 for the first time since 2018. Typically, EMs require a weak dollar, robust global trade, and a strong commodities environment to outperform. While the year began with all three conditions, the introduction of U.S. tariffs has created an uncertain trade outlook, potentially reversing these trends.
Trade is a crucial factor. During the first trade war, a prevailing investment narrative suggested that other EMs could benefit from U.S.-China trade tensions by attracting increased foreign direct investments and manufacturing as alternatives to China, which faced trade uncertainty.
However, this time is different as tariffs are being applied more broadly. Additionally, these economies now face the secondary shock of an influx of cheap Chinese imports, as China exports excess capacity amid subdued domestic demand and elevated trade tensions with the U.S. and other developed markets. This phenomenon is already negatively impacting local EM manufacturing and employment. As the Trump administration targets not just China but almost every trading partner with trade imbalances—whether due to trade deficits or tariff rate differentials—many EM economies could end up in the crosshairs. With both the direct impact of U.S. tariffs and the indirect impact of a slowing China and weaker global trade, EM economies may face tougher challenges ahead.
At a headline level, the narrative played out when comparing the evolution of the U.S. trade relationship with China and other EMs—particularly manufacturing powers like Vietnam and Mexico. The U.S. share of imports from China fell steadily from 2017 onwards, while the share from other EMs grew by almost the same magnitude.
In this regard, the U.S. has not fully achieved its goal of decoupling from China, especially in sensitive and strategic sectors. These cases of low local value-add (and high China-produced content) will likely come under further scrutiny by the U.S. as it seeks to reshape the global trade landscape and close trade loopholes exploited in the last trade war.
Moreover, it is difficult to ascertain the ‘true’ economic impact of increased Chinese investments in EM economies beyond headline FDI numbers. If these manufacturers are simply sourcing a vast majority of their inputs from China (for construction, labor, capital goods, intermediate components, etc.), then the benefits to the local economy may be limited to land sales and the provision of utilities. Anecdotally, that appears to be the case, but empirically measuring the actual economic impact of these investments is challenging.
In addition, the Chinese influx goes beyond just FDI and transshipments—EMs are also increasingly being flooded by Chinese imports meant for domestic consumption, with potentially negative implications for the local economy.
We have written extensively about how the U.S. has undergone significant economic shifts in terms of deindustrialization, weak manufacturing wage growth, and imbalances between capital and labor—and how some of these factors underpin the trade policies the Trump administration is currently pursuing. An interesting phenomenon today is how a similar shock could be playing out across EMs, largely attributed to China.
China’s exports started being targeted with tariffs by the U.S. in the first Trump administration (which the Biden administration maintained and, in some cases, expanded). Some manufacturers shifted production to other markets to circumvent those duties while also seeking alternative markets to sell to. A clear trend is that other EMs are taking up the slack from the U.S., as several large countries are now receiving an increasingly larger share of China’s exports.
This is creating a new shock for EMs. First, EM imports from China have surged, not just in intermediate goods, which make up more advanced products, but increasingly in final goods, which displace local industry and jobs. Meanwhile, EM exports to China have dropped, contributing to growing trade deficits. Secondly, China’s excess capacity is resulting in a surge of global exports, displacing other EM products in third markets.
So, what are some of the goods being imported from China? They range broadly from higher-end products such as electric vehicles and other appliances to lower-end clothing and textiles. While importing high-quality high-end products at competitive prices is arguably positive for consumers, a flood of lower-end imports can overwhelm local producers and lead to job losses.
Already, some economies are implementing measures to curb the impact. Mexico has raised tariffs on textile and apparel imports from China to 35%, and Thailand and Malaysia have levied a 7% and 10% value-added tax on cheap imported goods to mitigate Chinese e-commerce imports. However, these economies are treading a fine line between the U.S. and China, and it is challenging to balance their extensive trade relationships with both. On one side, the U.S. is trying to strategically reshape global trade, while on the other, China is trying to boost manufacturing and exports and find alternative markets for their products. Even Russia, which has become enormously reliant on trade with China, put restrictions on Chinese car imports due to an unsustainable inflow of cheap imports. China’s auto exports have been nothing short of historic—rising to become the largest exporter and manufacturer in the world in just five years.
The fundamental nature of this trade war is different from the first, as the scope is global rather than bilateral between the U.S. and China. As such, other EMs could be hurt by 1) the direct impact of reciprocal tariffs; 2) the indirect impact of a weaker global trade environment; and 3) a flood of Chinese imports.
To gauge the first-order impact of higher U.S. tariffs, we can consider the degree to which EMs rely on the U.S. as a destination for exports. In this regard, Vietnam, Mexico, Thailand, South Korea, and Taiwan stand out. These economies also happen to have some of the larger trade surpluses and tariff rate differentials versus the U.S., which could come under heavy scrutiny by the administration.
Emerging Markets tend to exhibit a very strong correlation to three things—trade, commodities, and the dollar. When trade and commodity prices are strong and the dollar is weak, EMs outperform. Investors often question why this correlation exists, highlighting that EM economies are less commodity-intensive or trade-dependent than they once were, but nonetheless, this relationship holds. We note that during the Covid period, EM slightly underperformed despite the strong trade and commodity backdrop, likely because the asset class was overwhelmed by a strong dollar and persistent flows into U.S. assets.
While today’s weaker USD and lower U.S. yields are usually regarded as a positive for EM broadly, the uncertain trade environment leads us to be more cautious and selective in this space. Furthermore, a large part of the EM outperformance this year has been led by China, and that particular rally was led by a handful of AI and tech-related names, which we don’t see as reflecting a fundamental change in the growth outlook or the global trade and economic environment. Our preferred equity markets globally are still the developed ones of the U.S. and Japan. If the dollar remains in a bear market and tariffs turn out to be less punitive than expected, the EM rally can continue. However, if tariffs are applied broadly, investors will likely have to be selective to find opportunities.
One key EM that could be less impacted by the external environment and more driven by constructive domestic factors is India, where we see a bottoming of economic momentum in sight. This could, in turn, lead to a recovery in the equity market, which has sold off significantly since late last year. We continue to see India as a long-term structural position in an equity portfolio. For long-term equity investors, it is important to consider the factors that drive EM long-term performance: economic structure, the role of private enterprise, earnings per share growth, and the role of exports.
All market and economic data as of March 28, 2025 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.
Indices are not investment products and may not be considered for investment.
Past performance is not a guarantee of future results. It is not possible to invest directly in an index.
Investing in alternative assets involves higher risks than traditional investments and is suitable only for sophisticated investors. Alternative investments involve greater risks than traditional investments and should not be deemed a complete investment program. They are generally not tax efficient and an investor should consult with his/her tax advisor prior to investing. Alternative investments have higher fees than traditional investments and they may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain. The value of the investment may fall as well as rise and investors may get back less than they invested.
Real estate, hedge funds, and other private investments may not be suitable for all individual investors, may present significant risks, and may be sold or redeemed at more or less than the original amount invested. Private investments are offered only by offering memoranda, which more fully describe the possible risks. There are no assurances that the stated investment objectives of any investment product will be met. Hedge funds (or funds of hedge funds): often engage in leveraging and other speculative investment practices that may increase the risk of investment loss; can be highly illiquid; are not required to provide periodic pricing or valuation information to investors; may involve complex tax structures and delays in distributing important tax information; are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any hedge fund.
RISK CONSIDERATIONS
Index definitions:
MSCI Emerging Markets (EM) Asia Index captures large and mid cap representation across Emerging Markets countries. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
MSCI AC Asia ex Japan Index captures large and mid cap representation across 2 of 3 Developed Markets (DM) countries* (excluding Japan) and 8 Emerging Markets (EM) countries in Asia.
Bloomberg Commodity Index (BCOM) is a benchmark index that tracks the performance of a basket of commodity futures contracts, aiming to provide broad-based exposure to the commodities market while minimizing concentration in any single commodity or sector.
We can help you navigate a complex financial landscape. Reach out today to learn how.
Contact usLEARN MORE About Our Firm and Investment Professionals Through FINRA BrokerCheck
To learn more about J.P. Morgan’s investment business, including our accounts, products and services, as well as our relationship with you, please review our J.P. Morgan Securities LLC Form CRS and Guide to Investment Services and Brokerage Products.
JPMorgan Chase Bank, N.A. and its affiliates (collectively "JPMCB") offer investment products, which may include bank-managed accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC ("JPMS"), a member of FINRA and SIPC. Insurance products are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states.
Please read the Legal Disclaimer (for J.P. Morgan regional affiliates and other important information) and the relevant deposit protection schemes.